Edited version of private advice

Authorisation Number: 1052215230247

Date of advice: 15 February 2024

Ruling

Subject: Deductions - legal expense

Question

Are the legal expenses incurred by you deductable under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

•         You were employed as the Chief Financial Officer (CFO) of Company A

•         Company A needed to get finance for the business to avoid the collapse of Company B

•         Company A applied to received finance from a Financer listing Company B as the borrower

•         The Financer stated that "You have to put your money where your mouth is" and would not release funds unless you also signed the contract as a guarantor

•         The directors as well as the CEO of Company A expected you to sign the loan agreement as the funds were needed for the business

•         You signed the contract as a guarantor on a specified date

•         On a specified date Company A went into administration along with its affiliated companies including Company B

•         You stated that the 2 directors who had provided a guarantor alongside you had their assets held within a trust. This resulted in the Financer taking you to court to recover the funds they had lost

•         You hired lawyers to fight the charges brought against and negotiate with the Financer to find a resolution

•         You spent funds during the ruling period on legal expenses

•         You did not have any ownership in Company A

•         You did not have the responsibility of being a guarantor of loans in your employment contract

•         You provided a copy of your employment contract

•         You provided a copy of the contract between Company A and the Financer

•         You provided a copy of the statement of claim filed by the Financer's attorney

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenses must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses, that is, whether the legal expenses are incurred for a capital or revenue purpose. The outcome of the legal action does not affect the deductibility of the legal expense, rather the nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses.

In your case your legal expense was a result of you agreeing to become a guarantor and having to defend yourself when the Financer took you to court to reclaim their funds. We need to assess if the decision to become a guarantor was made in relation to gaining or producing assessable income. In your case you were producing assessable income in the role of CFO for Company A.

We must then incur if the expenditure had a sufficient nexus between you and your employment activities. You provided a copy of your employment contract stating your responsibilities in the role. The contract showed that it is not a responsibility of your position as CFO to be a guarantor for Company A when it seeks financing, nor is it considered within the general job description of a CFO to take on the responsibility of guarantor for their employer.

Though we understand you may have felt pressure from the CEO to become guarantor so Company A could receive the loan there is not a genuine connection between this and your employment activities. We can than conclude that the decision to sign was not incurred in producing assessable income.

Furthermore, we considered if you were producing assessable income though shares or ownership within the business. You had no ownership of Company A and so no consideration can be given to if you were trying to preserve income produced from an investment asset.

As a result, the choice to become guarantor which eventually led to the legal expenses you incurred are not considered to be an expense incurred in producing assessable income under section 8-1 of the ITAA 1997.